Business debt consolidation is the process of combining multiple debts into one loan.
Indeed, securing a small business debt consolidation loan may carry advantages beyond cost savings — but there may be some drawbacks, too. Consolidation is certainly worth considering to achieve better rates and terms if you have multiple loans with high-interest rates and have improved both your personal and business finances.
What Is Business Debt Consolidation?
Debt consolidation, whether for professional or personal means, is a method of securing a new loan to pay off several debts. In using a business consolidation loan, business owners are often able to consolidate many smaller loans that are often unsecured and higher interest. (An aside: Business consolidation loans that are unsecured? They’re possible. Merchant cash advances, for example, generally are unsecured.)
These debts are combined into one larger loan. Small business owners can use debt consolidation as a tool to better manage credit-card debt, equipment loans and many other types of financing.
Consolidating debt can eliminate many of the monthly payments your business is making and, though it isn’t a guaranteed benefit of debt consolidation, potentially reduce the interest rates on that debt.
How a Business Debt Consolidation Loan Works
In its purest form, a small business debt consolidation loan takes any applicable accounts and payments and bundles them into a single loan payment. The process involves combining many different loans into a single new loan with one monthly payment.
Consolidating eliminates the need to remember multiple loan payment due dates, with a single, consistent payment.
If your business is struggling to manage the different repayment schedules in your organization, a business debt consolidation loan can bring a great deal of simplicity to your debt management.
The Difference Between Business Debt Consolidation and Refinancing
Refinancing and debt consolidation are terms that are sometimes used interchangeably, but they describe two distinct processes. While business debt consolidation is a form of refinancing, it’s important to recognize the differences between them.
Refinancing: The practice of obtaining a new loan at a lower interest rate as a means of paying off other, higher-interest loans.
Debt Consolidation: The practice of combining multiple loans into one new loan with a single payment.
It’s important to note that debt consolidation doesn’t mean that you will receive a condensed loan with a lower interest rate.
While it would be terrific if your business debt consolidation loan saved you money in interest fees, the primary goal of debt consolidation is to make payments more manageable by eliminating several payments with one. Business debt consolidation loan rates are sometimes very similar to other loan terms.
How to Know It’s Time for a Small Business Debt Consolidation Loan
Regardless of what your financial picture may have looked like when you first took on business debt, it’s possible that you could now be eligible to secure better rates and terms. If your finances have improved, consolidation is certainly worth considering.
Here are some signals that you may want to consolidate your small business debt:
You Have More Than a Few High-Interest Loans
The higher your current interest rates, the more beneficial it will be for you to pursue small business debt consolidation.
If you’ve taken out one or more cash advances for your business, for example, those products can charge relatively high interest rates. However, business cash advances could be combined with a debt consolidation loan and save you a lot of money over the long run.
As you’re applying for a new, lower-interest-rate business loan, the same qualification and approval factors that were used to evaluate your business originally will be used again. These include how long you’ve been in business, your personal credit score and your business’s annual revenue.
It only takes one of those factors to have improved to qualify your business for a debt consolidation loan at a lower rate than your current loans.
You Want to Extend a Short-Term Loan
When entrepreneurs take out loans, they often do so intending to expand their business. However, there are moments when owners need a longer time to see a positive return on their investment. A business debt consolidation loan is 1 way businesses can guarantee themselves more time before having to repay the debt in full.
Make sure that the revenues you’re counting on will be enough to cover the full amount of the loan—including additional interest that will accrue.
Your Personal Credit Is Above 620
For a lender to assist you in debt consolidation, they must first check your personal credit. Any interest rates and terms that a lender is ultimately willing to offer are significantly affected by personal credit.
To help you understand your personal credit score and what’s considered good, let’s review the score categories below:
- Very Poor: 300-579
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800-850
Any credit score above 700 is typically seen as good or excellent. With a score this high, banks and lenders will be competing to offer your business the lowest interest rate. Owners with scores between 620 and 700 who’ve been in business for over a year will also have attractive options to lower their interest rates through consolidation. However, it’s likely there won’t be as many suitors involved.
For entrepreneurs with credit scores in the range of 550-620, there’s no guarantee you’ll be able to consolidate at a rate lower than any of your current loans. Finding a consolidation loan that would benefit you would be dependent on finding the right financing partner, as well as having multiple years in business and strong annual revenues.
You’ve Improved Your Business Finances
If your business’s revenue or profitability has improved month-over-month for 3 straight months, your chances of qualifying for a lower consolidation loan increase.
The minimum business revenue required to consolidate your debt is typically $25,000. The amount you qualify for depends on the lender, your credit score, your annual revenue and other factors.
You’ve Improved Your Personal Finances
As with credit scores, personal finances matter a great deal for a small business owner, especially when it comes to small business debt consolidation.
Qualifying for a business debt consolidation loan means having improved any of the following aspects of your personal finances:
- Increased personal income (via sources other than your business)
- Reduced personal debt
- Lowered household spending
- Increased real estate equity
- Lowered your number of dependents
Note that if your credit hasn’t improved lately, a consolidation loan may not save you money on interest payments. While securing a business debt consolidation loan with bad credit might be possible, it may not be practical because of the extremely high interest.
You’ve Been in Business More Than 1 Year
Whenever you apply for a business loan, the longer you’ve been in business, the more it will help you in securing a business debt consolidation loan with a lower interest rate.
Organizations with longer financial histories have more ways to demonstrate their ability to sustain success and profitability to lenders. Before applying for a business debt consolidation loan, your organization should be in operation for at least one year.
Consolidating Your Business Debt in 6 Steps
Once you’ve determined that you’re a good candidate for debt consolidation, it’s time to move forward. There are 6 essential steps to condensing your debt, starting with what you’re currently responsible for.
1. Understand the Current Terms of Your Debt
The first step involves understanding the types of debt you’re consolidating and the terms they carry. This will help you know when is the right time to consolidate your debt.
For example, it’s common to want to consolidate the highest interest rate loans first. While this is understandable, your current loans may have restrictions keeping you from consolidating them. Debt holders often forget to include the cost of prepayment penalties or other refinancing costs into their total calculations.
Although consolidating to a cheaper interest rate may look great in theory, in principle, it can be a costly mistake if the unification triggers additional fees or penalties. This makes being aware of the fine print extremely important when you’re consolidating.
2. Weigh Your Potential Options vs. Current Debt
Once you’ve gathered all the details about your outstanding loans, establish whether consolidating will save you money. Before you can appropriately weigh your options, we recommend that you speak with a certified public accountant to double-check that you haven’t overlooked something in the numbers or the language of your current debt terms.
3. Outline Which Debts to Consolidate
You may be in a position to consolidate some, but not all, of your debt. The rates you have on one loan may be far better than the rates you have on another. Regardless, you need to have come up with an approach of how you’re planning to reduce the number of payments and interest rates you currently have.
Even if you’re unable to consolidate all of your debts, reducing what you can (as long as it’s a net positive for your business) is still worthwhile.
4. Determine Your Qualifications
As with any other loan, each lender will have different requirements for a debt consolidation loan. However, there are a few universal qualifications that you can be confident in before applying.
These basic elements include:
- At least 1 year in business
- Annual revenue of $100,000+
- A personal credit score of 600+
- A debt service coverage ratio of 1.2 or better
5. Organize Your Documents
Having the right documentation prepared before applying not only gives you peace of mind—it also helps keep the approval process from stalling.
For example, SBA loans (including SBA Express loans) can take weeks, even months to be approved. The best way to expedite this process and keep everything on track is to be prepared with the right documentation before applying.
When it’s time to apply, you want to be able to trust the advice your lender shares with you. As crucial as steps 1 through 5 are, choosing from the best small business debt consolidation companies is arguably the most critical.
Indeed, the lender you choose to work with could mean the difference between saving a few thousand dollars and increasing your costs over the long run.
Many financing partners simplify the process by offering a streamlined online application that only takes a few minutes to see if you prequalify, handling administrative details in the process.
The Two Best Loan Types for Business Debt Consolidation
When you’re looking to reduce your business debt, only a few loan types allow you to consolidate properly. For example, short-term business loans are excellent for small projects and infusions of working capital but aren’t appropriate for unifying all of your debts into one, simplified payment. Indeed, short-term loans are meant to be paid off or refinanced within 18 months.
The 2 main options for entrepreneurs looking to consolidate their business debt are term loans and SBA loans.
Conventional Term Loans
Typically, a term loan is the best option for businesses looking to consolidate.
Conventional term loans offer the lowest interest rates with the longer repayment terms, typically about 10% interest for 10 years. Regardless of whether you apply with one of the big national banks or a local independent institution, banks will only approve qualified applicants.
In most scenarios, this means that a business has been in operation for one year or more with an annual revenue of at least $100,000 and an owner with a personal credit score of 600 or higher.
If a business owner is unable to secure a term loan, their next option is typically pursuing an SBA loan, which is intended for owners who may not meet the qualifications of a conventional bank loan but still have strong credit.
One of the most popular programs, an SBA 7(a) loan, offers terms up to 25 years with amounts as high as $5,000,000 and interest rates starting at Prime plus 2.75% for loans over $50,000.
Managing debt is a key element of running a successful operation. While taking on debt can, at times, be the best way for your business to grow, it can also hinder your growth.
Keep an eye on your debt-to-income ratios and continue to find ways to reduce your debt. Both of these pieces will help you reach your organizational goals and position you to do more with the revenue you do generate.
Ultimately, if your business is managing multiple debts, it makes sense to consolidate if you’ll pay the same or less money overall. However, if you need to centralize your debts to improve your operational cash flow, spending a bit more over the long-term might be worth it, depending on your circumstances.